Advanced financial accounting by baker chapter 04

100 percent ownership acquired at book value • Peerless acquires all of Special Foods’ common stock for $300,000, an amount equal to the fair value of Special Foods as a whole – On the

Consolidation

of Wholly Owned Subsidiaries

4

Consolidation Procedures

• The starting point for preparing consolidated financial statements is the books of the

separate consolidating companies

– The consolidated entity has no books

– Amounts in the consolidated financial

statements originate on the books of the parent

or a subsidiary or in the consolidation

workpaper

Consolidation Workpapers

• The consolidation workpaper a mechanism for:

– Combining the accounts of the separate companies

involved in the consolidation

– Adjusting the combined balances to the amounts that

would be reported if all consolidating companies were

actually a single company

• When consolidated statements are prepared, the

account balances are taken from the separate

books of the parent and each subsidiary and placed

in the consolidation workpaper

• The consolidated statements are prepared, after

adjustments and eliminations, from the amounts in

the workpaper

Consolidation Workpapers

• Eliminating entries

– Used to adjust the totals of the individual account

balances of the separate consolidating companies to

reflect the amounts that would appear if all the legally

separate companies were actually a single company

– Appear only in the consolidating workpapers and do not affect the books of the separate companies

– Used to increase or decrease the combined totals for

individual accounts so that only transactions with

external parties are reflected in the consolidated

Consolidated Balance Sheet with Wholly Owned Subsidiary - Illustration

Total Liabilities and Equity $1,100,000 $500,000

Balance Sheets of Peerless Products and Special Foods, January 1, 20X1, Immediately before Combination

Back

100 percent ownership acquired at

book value

• Peerless acquires all of Special Foods’ common

stock for $300,000, an amount equal to the fair

value of Special Foods as a whole

– On the date of combination, the fair values of Special Foods’ individual assets and liabilities are equal to

their book values

– Peerless records the stock acquisition on its books:

January 1, 20X1

Investment in Special Foods Stock 300,000

100 percent ownership acquired at

Total Liabilities and Equity $1,100,000 $500,000

Balance Sheets of Peerless Products and Special Foods,

January 1, 20X1, Immediately after Combination

Workpaper for Consolidated Balance Sheet,

January 1, 20X1, Date of Combination;

100 Percent Acquisition at Book Value

Investment elimination entry

100 percent ownership acquired at

book value

• The consolidated balance sheet is prepared directly from the last column of the consolidation workpaper

100 Percent Ownership Acquired at

More than Book Value

Peerless records the stock acquisition:

Peerless acquires all of Special Foods’ outstanding stock on January 1, 20X1, by paying $340,000 cash, an amount equal to Special Foods’ fair value as a whole The consideration given by Peerless is $40,000 in excess of Special Foods’ book value of $300,000

January 1, 20X1

Investment in Special Foods Stock 340,000

100 Percent Ownership Acquired at

More than Book Value

• The workpaper entry to eliminate Peerless’s investment account and the stockholders’ equity accounts of Special Foods is:

• The fair value, and hence acquisition price, of a

subsidiary might exceed the book value for several

reasons:

• Errors or omissions on the books of the subsidiary

• Excess of fair value over the book value of the subsidiary’s net identifiable assets

• Existence of goodwill

Eliminate investment balance.

100 Percent Ownership Acquired at

More than Book Value

• Errors or omissions on the books of the subsidiary

– Corrections should be made directly on the subsidiary’s books as of the date of acquisition

• Excess of fair value over book value of subsidiary’s net identifiable assets

– The assets and liabilities of the subsidiary may be

revalued directly on the books of the subsidiary

– The accounting basis of the subsidiary may be

maintained and the revaluations made each period in

the consolidation workpaper

100 Percent Ownership Acquired at

More than Book Value

If the fair value of Special Foods’ land is determined to be $40,000

more than its book value, and all other assets and liabilities have fair

values equal to their book values, the entire amount of the differential

is allocated to the subsidiary’s land

Assign differential to land

Workpaper for Consolidated Balance Sheet,

January 1, 20X1, Date of Combination;

100 Percent Acquisition at More than Book Value

100 Percent Ownership Acquired at

More than Book Value

• Existence of goodwill

– Related to the future economic benefits

associated with other assets of the subsidiary

that are not separately identified and

recognized

Assuming that the acquisition-date fair values of Special Foods’ assets

and liabilities are equal to their book values, then the $40,000 difference

between the $340,000 consideration exchanged and the $300,000 fair

value of the subsidiary’s net identifiable assets is attributed to goodwill

E(6) Goodwill 40,000

Assign differential to goodwill.

Illustration of Treatment of Debit

Differential

Assume that the acquisition-date book values and fair values of Special Foods’ assets and liabilities are as shown

Illustration of Treatment of Debit

Differential

Assume that Peerless Products acquires all of Special Foods’ capital stock for $400,000 on January 1, 20X1, by issuing $100,000 of 9 percent bonds, with a fair value of $100,000, and paying cash of $300,000 The resulting ownership situation can be pictured as follows:

Peerless records the investment on its books with the following entry:

Illustration of Treatment of Debit

Illustration of Treatment of Debit

Differential

The eliminations entered in the consolidation workpaper in preparing the

consolidated balance sheet immediately after the combination are:

Eliminate investment balance.

Assign differential

These entries are reflected in the workpaper in the next slide

Workpaper for Consolidated Balance Sheet,

January 1, 20X1, Date of Combination;

100 Percent Acquisition at More than Book Value

100 Percent Ownership Acquired at

Less than Fair Value of Net Assets

• Bargain purchase:

– A business combination where the sum of the

acquisition-date fair values of the consideration given, any equity interest already held by the

acquirer, and any noncontrolling interest is less than the amounts at which the identifiable net

assets must be valued at the acquisition date

as specified by FASB 141R

for the difference

Illustration of Treatment of

Bargain-Purchase Differential

Assume that the acquisition-date book values and fair values of Special Foods’ assets and liabilities are equal except that the fair value of Special Foods’ land is $40,000 greater than its book value On January 1, 20X1, Peerless acquires all of Special Foods’ common stock for $310,000, resulting

in a bargain purchase The resulting ownership situation is as follows:

Peerless records its investment in Special Foods with the following entry on its books:

January 1, 20X1

Illustration of Treatment of

Bargain-Purchase Differential

The purchase price exceeds Special Foods’ book value by only $10,000 and, thus, is less than the fair value of the net identifiable assets acquired

Assuming push-down accounting is not employed, if a consolidated balance

sheet is prepared immediately after the combination, the following eliminating entries are included in the consolidation workpaper:

E(11) Common Stock—Special Foods 200,000

Investment in Special Foods Stock 310,000

Eliminate investment balance.

Retained Earnings (Gain on Bargain Purchase) 30,000

Assign differential in bargain purchase.

Illustration of Treatment of

Eliminate investment balance.

– However, in addition to the assets and liabilities, the

revenues and expenses of the consolidating companies must be combined

– Eliminations must be made in the consolidation

workpaper so that the consolidated statements appear

as if they are the financial statements of a single

company

Consolidation Subsequent to

Acquisition

• Consolidated Net Income

– In the absence of transactions among the

consolidating companies, consolidated net

income is equal to the parent’s income from its own operations, excluding any investment

income from consolidated subsidiaries, plus the net income from each of the consolidated

subsidiaries, adjusted for any differential

write-off

– Includes 100 percent of the revenues and

Consolidation Subsequent to

Acquisition

• Consolidated retained earnings

– That portion of the consolidated enterprise’s

undistributed earnings accruing to the parent

company shareholders

– Consolidated retained earnings at the end of

the period is equal to the beginning

consolidated retained earnings balance plus

consolidated net income attributable to the

controlling interest, less dividends declared by the parent company

Format for Comprehensive Three-Part Consolidation Workpaper

Consolidated Financial Statements—100

Percent Ownership Acquired at Book Value

Assume that on January 1, 20X1, Peerless Products Corporation acquires

all of the common stock of Special Foods Inc for $300,000, an amount

equal to the book value of Special Foods on that date At that time, Special

Foods has $200,000 of common stock outstanding and retained earnings of

$100,000 Following information is available:

Consolidated Financial Statements—100 Percent

Ownership Acquired at Book Value

Investment in Special Foods Stock 30,000

Record dividends from Special Foods: $30,000 X 1.00

Investment in Special Foods Stock 50,000

Record equity-method income: $50,000 X 1.00

December 31, 20X1, Equity-Method Workpaper for

Consolidated Financial Statements, Initial Year

of Ownership; 100 Percent Acquisition at Book Value

Consolidated Financial Statements—100 Percent

Ownership Acquired at Book Value

Second and subsequent years of ownership Peerless’s separate

income from its own operations for 20X2 is $160,000, and its dividends

total $60,000 Special Foods reports net income of $75,000 in 20X2 and

pays dividends of $40,000 Entries:

Investment in Special Foods Stock 40,000

Record dividends from Special Foods: $40,000 x 1.00

Investment in Special Foods Stock 75,000

Record equity-method income: $75,000 x 1.00

Eliminating Entries

E(22) Income from Subsidiary 75,000

Investment in Special Foods Stock 35,000

Eliminate income from subsidiary.

Consolidated Financial Statements—100 Percent

Ownership Acquired at Book Value

• Consolidated net income and retained

earnings

Consolidated Financial Statements—100 Percent

Ownership Acquired at More than Book Value

Peerless acquires all of Special Foods’ common stock on January 1, 20X1, for

$387,500, an amount $87,500 in excess of the book value Acquisition price includes cash of $300,000 and a 60-day note for $87,500 (paid at maturity during 20X1) At that date, Special Foods is holding the assets and liabilities shown in Slide 7 On the date of combination, all of Special Foods’ assets and liabilities have fair values equal to their book values, except as follows:

Fair Value Book Value Fair Value Increment Inventory $60,000 $65,000 $5,000

Consolidated Financial Statements—100 Percent

Ownership Acquired at More than Book Value

For the first year immediately after the date of combination, 20X1, Peerless earns income from its own separate operations of $140,000 and pays $60,000 dividends Special reports net income of $50,000 and pays $30,000 dividends

Parent Company Entries:

Investment in Special Foods Stock 387,500

Record purchase of Special Foods

Investment in Special Foods Stock 30,000

Record dividends from Special Foods.

Investment in Special Foods Stock 50,000

Record equity-method income.

Investment in Special Foods Stock 5,000

Consolidated Financial Statements—100 Percent

Ownership Acquired at More than Book Value

E(29) Income from Subsidiary

Dividends Declared Investment in Special Foods Stock

Eliminate income from subsidiary.

E(30) Common Stock—Special Foods

Retained Earnings, January 1 Differential

Investment in Special Foods Stock

Eliminate beginning investment balance.

E(31) Cost of Goods Sold

Land Buildings and Equipment Goodwill

Differential

Assign beginning differential.

E(32) Depreciation Expense

Accumulated Depreciation

Amortize differential related to buildings and equipment

E(33) Goodwill Impairment Loss

Goodwill Eliminating entries

Consolidated Financial Statements—100 Percent Ownership Acquired at More than Book Value

Consolidated Financial Statements—100 Percent

Ownership Acquired at More than Book Value

Second Year of Ownership: During 20X2, Peerless earns income from its

own separate operations of $160,000 and pays dividends of $60,000; Special Foods reports net income of $75,000 and pays $40,000 dividends No further

impairment of the goodwill occurs

Parent Company Entries

Investment in Special Foods Stock 40,000

Record dividends from Special Foods.

Investment in Special Foods Stock 75,000

Record equity-method income.

Investment in Special Foods Stock 6,000

Amortize differential related to buildings and equipment.

Consolidated Financial Statements—100 Percent Ownership Acquired at More than Book Value

The changes in the parent’s investment account for 20X1 and 20X2 can be

summarized as follows:

Consolidated Financial Statements—100 Percent Ownership Acquired at More than Book Value

Eliminating entries at the end of 20X2

E(37) Income from Subsidiary 69,000

Dividends Declared 40,000 Investment in Special Foods Stock 29,000

Eliminate income from subsidiary.

E(38) Common Stock—Special Foods 200,000

Retained Earnings, January 1 120,000 Differential 76,500

Investment in Special Foods Stock 396,500

Eliminate beginning investment balance.

Buildings and Equipment 60,000 Goodwill 12,500

Differential 76,500 Accumulated Depreciation 6,000

Assign beginning differential.

E(40) Depreciation Expense 6,000

Accumulated Depreciation 6,000

Consolidated Financial Statements—100 Percent

Ownership Acquired at More than Book Value

Consolidated Net Income and Retained Earnings, 20X2; 100 Percent

Acquisition at More than Book Value

Intercompany Receivables and

Payables

• All forms of intercompany receivables and

payables need to be eliminated when

consolidated financial statements are

prepared

• If no eliminating entry is made, both the

consolidated assets and liabilities are

overstated by an equal amount

Push-Down Accounting

• Push-down accounting refers to the practice of

revaluing an acquired subsidiary’s assets and

liabilities to their fair values directly on that

subsidiary’s books at the date of acquisition

– The revaluations are recorded once on the subsidiary’s books at the date of acquisition and, therefore, are not

made in the consolidation workpapers each time

consolidated statements are prepared

– SEC Staff Accounting Bulletin No 54 requires

push-down accounting whenever a business combination